May 26 2010OECD urges tax rises and spending cuts
Public spending cuts and tax rises in advanced economies are required by next year at the latest to deal with “very unfavourable government debt dynamics”, the Organisation for Economic Co-operation and Development warned on Wednesday.
In its twice-yearly Economic Outlook, the Paris-based international organisation for advanced economies also saw the need for interest rates in the US, UK and Canada to start rising by the end of the year, as the world economic recovery continues.
Calling for urgent action in both fiscal and monetary policy in unusually strident language, the OECD worried that the market turmoil of recent weeks in response to the Greek sovereign debt crisis risked spreading if governments failed to get a grip on their budgets and central banks delayed normalisation of interest rates unnecessarily.
With its forecasts expecting a continuation of growth in the world economy at faster rates than before the crisis, the OECD economists urged governments to announce credible deficit reduction plans to start soon.
“Exit from exceptional fiscal support must start now, or by 2011 at the latest,” Pier Carlo Padoan, the OECD chief economist said. He said the budgetary plans should be “based on credible and well-articulated medium-term consolidation plans to restore fiscal soundness”.
“Countries at risk of losing confidence in financial markets also need to strengthen government finances more rapidly,” the report added.
The OECD’s concern is that public sector debt is poised to continue rising, something that is unsustainable and would lead to a sovereign debt crisis across advanced economies. “Even if countries adhere to [their current] plans, in contrast to frequent slippages in the past, current programmes in many OECD countries may not suffice to halt adverse debt dynamics, particularly if growth remains more subdued than assumed.”
The organisation singled out the US for particular criticism, saying its budgetary plans “would not suffice to stabilise the US debt-to-GDP ratio without further amendment.”
Even in fiscally prudent Germany, the OECD said “a concrete consolidation strategy for meeting the budgetary target is not yet available and will need to be developed”.
The OECD warned that if countries failed to heed its advice, they risked “adverse reactions in financial markets” and higher long-term interest rates. Eurozone countries were urged to establish rules for the new stabilisation fund quickly to avoid the provision of support being seen as subject to significant political risk.
To buy time for budgetary tightening, the OECD said countries should publish detailed plans to get their public finances in order, be clear about what they would do if different circumstances arrived, cut spending more than raise taxes and enhance the credibility of their plans by subjecting them to independent monitoring.
This is exactly the strategy undertaken by the new Con-Lib coalition government in the UK, which will announce harsh spending cuts and tax increases in an emergency Budget on 22 June.
A secondary benefit of greater fiscal credibility is that it will help keep public expectations of inflation in check, the OECD said, “providing the monetary authorities with the room to slow down the normalisation of interest rates”.
For the US, the OECD said that the rapid recovery implied interest rates rises “should not be delayed beyond the last quarter of 2010” and it thought rates should hit 3.5 per cent by the end of 2011.
The Bank of Canada should start raising interest rates almost immediately and the Bank of England must respond to “the gradual drift up of some measures of inflation expectations” by raising rates “no later than the last quarter of 2010”.
Only in the eurozone and Japan did the OECD see the need for extraordinarily low interest rates to continue for longer.
The backdrop to the OECD’s policy recommendations is faster economic growth than it expected last October. It said risks were higher since the latest worries on sovereign debt emerged, but these fears were possible to contain as long as the authorities took the necessary action.
This, it said, would bolster the recovery rather than undermine it, because it would boost confidence among companies and households.
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